All About High-Frequency Trading

All About High-Frequency Trading examines the practice of deploying advanced computer algorithms to read and interpret market activity, make trades, and pull in huge profits—all within milliseconds. Whatever your level of investing expertise, you’ll gain valuable insight from All About High-Frequency Trading’s sober, objective explanations of:

• The markets in which high-frequency traders operate
• How high-frequency traders profi t from mispriced securities
• Statistical and algorithmic strategies used by high-frequency traders
• Technology and techniques for building a high-frequency trading system
• The ongoing debate over the benefi ts, risks, and ever-evolving future of high-frequency trading

Introduction:

What is high-frequency trading? Great question! And it’s about time for an answer, because everyone seems to be talking about it—and forming strong opinions about it—and when that happens, it’s usually a good thing to know just what it is. Does high- frequency trading relate only to stock trading? Or does it include automated trading of stock derivatives such as options? Does it encompass any type of automated trading, where computers make the decisions humans once did? Or does it pertain only to the dubious practices of the sharks sophisticated trading firms who, like the merchant above, move markets in their favor just because they can get away with it? Well, since nobody can quite answer these questions, let’s just make our own definition and get on with it.

In general, high-frequency trading (HFT) refers to the buying or selling of securities wherein success depends on how quickly you act, where a delay of a few thousandths of a second, or milliseconds, can mean the difference between profit and loss. HFT happens not only in the stock markets but in the markets for stock options and futures as well. Naturally, not every reason for trading requires speedy execution. Certainly not, say, buying stock because you think the company will do well over the coming years or cashing out your 401(k) to buy the Harley you’ve had your eye on since you were sixteen. But plenty of trading strategies do indeed depend on how quickly you can spot a profitable trading opportunity in the market—and how quickly you respond with a trade order to seize that opportunity before somebody else does. We’ll describe a number of such strategies later on.

The high-frequency trader evolved from the ranks of the traditional market-maker, or specialist, whose primary source of profit was the spread between the prices at which he bought and sold. Unlike the traditional market-maker, however, and owing to developments like decimalization2 and advances in technology, the high-frequency trader must settle for much narrower spreads—razor-thin margins of a penny or less. As such, high-frequency traders operate in massive scales. Indeed, the larger high- frequency trading firms now glide through the markets scooping up vast mouthfuls of trades like a whale does krill.

Contents:

• Busted
• Trading 101
• Trading Strategies
• Achieving Speed
• Under the Hood
• The High-Frequency Trading Debate